Demystifying the Private Fund Adviser Rules

The U.S. Securities and Exchange Commission (SEC) issued a series of final rules earlier this year that will significantly impact how private equity and hedge funds deal with investors, including requiring increased disclosure of fees and expenses, investments, and performance. The new rules also require private fund managers to disclose, and in some cases, get investor consent before engaging in certain activities, like allocating expenses on a non-pro rata basis or charging the fund fees and expenses associated with a governmental investigation. The adopting release created the Private Fund Adviser Rules.

Briefly, the new rules impose the following requirements applicable to registered investment advisers to private funds:

1. Quarterly Reporting: Provide investors with quarterly fee, expense, investment and performance reporting (new Advisers Act Rule 211(h)(1)-1).
2. Restricted Activities: Provide disclosure to, and, in some cases, obtain consent from investors before charging certain fees to the funds, collecting adviser clawbacks, charging fees and expenses related to portfolio investment from a pro rata allocation, and borrowing funds from another fund advised by the adviser. This rule applies to unregistered advisers to private funds as well (new Advisers Act Rule 211(h)(2)-1).
3. Preferential Treatment Prohibitions: Requires advance written notice of preferential treatment regarding redemption rights and portfolio holdings or exposure information (new Advisers Act Rule 211(H)(2)-3).
4. Adviser-led Secondary Requirements: Obtain a fairness or valuation opinion before engaging in an advisor-led secondary transaction and distribute a written summary of material business relationships with the opinion provider to all investors (new Advisers Act Rule 211(h)(2)-2).
5. Audited Financial Statements: Obtain a financial statement audit by an independent auditor prepared in accordance with U.S. Generally Accepted Accounting Principals (GAAP) (same requirements as defined in the Advisers Act Custody Rule (Rule 206-4(7)) for each fund they advise, except for securitized asset funds (new Advisers Act Rule 206(4)-10).
6. Documentation of Annual Compliance Program Review: Advisers document the annual review of the compliance program mandated under Advisers Act Rule 206(4)-7.

Below are the implementation dates for each of the new rules.

Rules	Implementation Date	Applicability	Grandfathering
Quarterly Statement Rule 211(h)(1)-2	March 14, 2025 - 18 months after publication in the Federal Register	Registered investment advisers to private funds (exclusion for securitized asset funds)	N/A
Restricted Activities Rule 211(h)(2)-1	Advisers with more than $1.5 billion of AUM: September 14, 2024 - 12 months after publication in the Federal Register Advisers with less than $1.5 billion of AUM: Mach 14, 2025 - 18 months after publication in the Federal Register	All advisers to private funds (exclusion for securitized asset funds)	Allows contractual agreements governing a private fund to remain in place that were entered into prior to the compliance date, except that an adviser cannot charge or allocate to the private fund fees or expenses for an investigation that results in sanctions for violations of the Advisers Act or the rules thereunder.
Preferential Treatment Rule 211(h)(2)-2	Advisers with more than $1.5 billion of AUM: September 14, 2024 - 12 months after publication in the Federal Register Advisers with less than $1.5 billion of AUM: Mach 14, 2025 - 18 months after publication in the Federal Register	All advisers to private funds (exclusion for securitized asset funds)	Allows written arrangements for preferential liquidity and information rights entered before the compliance date to stay in place
Adviser-Led Secondaries, Rule 211(h)(2)-2	Advisers with more than $1.5 billion of AUM: September 14, 2024 - 12 months after publication in the Federal Register Advisers with less than $1.5 billion of AUM: Mach 14, 2025 - 18 months after publication in the Federal Register	Registered investment advisers to private funds (exclusion for securitized asset funds)	N/A
Audit Rule 206(4)-10	March 14, 2025 - 18 months after publication in the Federal Register	Registered investment advisers to private funds (exclusion for securitized asset funds)	N/A
Documentation of Annual Review Rule 206(4)-7(b)	November 13, 2023 - 60 days after publication in the Federal Register	Registered investment advisers	N/A

Quarterly Statement Rule

New Rule 211(h)(1)-2 requires SEC-registered private fund advisers to prepare and distribute a quarterly statement that includes information regarding fees, expenses, and performance to the private fund’s investors. The goal of the new rules is to provide clear and simple disclosures to existing investors and allow these investors to better understand their private fund investments. The Quarterly Statement Rule is broken out into 6 sections:

1. Fee and Expense Disclosure: The rule requires an investment adviser to prepare and distribute quarterly statements that include information regarding the fund’s fees and expenses and any compensation paid or allocated to the adviser or its related persons of the fund.
   • Private Fund Level Disclosure: At the total fund level, the rule requires private fund advisers to disclose in a table format:
     • Adviser Compensation (i.e., all compensation, fees, and other amounts allocated or paid to the adviser or any of its related persons)
     • Fund Expenses (i.e., all fees and expenses allocated to or paid by the private fund)
     • Offsets and Rebates (i.e., any offsets or rebates carried forward during the reporting period to subsequent quarterly periods to reduce future payments or allocations)
   • Portfolio Investment-Level Disclosure: The rule also requires advisers to disclose all portfolio investment compensation allocated or paid by each covered portfolio investment in a single table during the reporting period. Advisers are required to disclose portfolio level compensation (i.e., management, consulting, monitoring, servicing, transaction, administrative, advisory, closing, disposition, similar fees).
     • Note: The adviser is required to list the portfolio investment level compensation before and after the application of offsets, rebates, or waivers.
   • Calculations and Cross-References to Offering Documents: To help investors find additional information on any fee or expense disclosure, the quarterly statements must include cross-references to the relevant sections of the private fund’s offering and organizational documents.
2. Performance Disclosure: The rule requires advisers to show standardized fund performance in each quarterly statement. The required fund performance will differ between liquid and illiquid funds.
   • Liquid Funds: Defined as any private fund that is not an illiquid fund (i.e., allows voluntary redemptions/withdrawals). Advisers are required to show:
     • Net Total Return on an annual basis for the 10 fiscal years prior to the quarterly statement or since the fund’s inception (whichever is shorter)
     • Annualized Net Total Return over one-, five-, and 10- fiscal year periods
     • Cumulative Net Total Return for the current fiscal year (i.e., Year-to-Date) as of the end of the most recent fiscal quarter
   • Illiquid Funds: Defined as a private fund that (i) is not required to redeem interests upon an investor’s request and (ii) has limited opportunities, if any, for investors to withdraw before termination of the fund. Advisers are required to show:
     • Gross and net since-inception internal rate of return and gross and net multiple of invested capital for the total fund. Both must be computed with and without the impact of fund-level subscription facilities, if applicable.
     • Gross internal rate of return and gross multiple of invested capital for the realized and unrealized portions of the illiquid fund’s portfolio, shown separately.
     • Statement of Contributions and Redemptions (i.e., the aggregate cash inflows from investors and the aggregate cash outflows from the fund to investors, along with the fund’s net asset value)
   • Prominent Disclosure of Performance Calculation Information: The rule will require advisers to include prominent disclosure of the criteria used and assumptions made in calculating the performance for the fund being shown. The disclosures must be readily noticeable and included within the quarterly statement.
3. Preparation and Distribution of Quarterly Statements: The rule requires quarterly statements to be prepared and distributed on a timely basis.
   • Funds that aren’t Fund of Funds (i.e., most funds): Quarterly statements are due 45 days after the first three fiscal quarter ends of each fiscal year and 90 days after the end of each fiscal year.
   • Fund of Funds: Quarterly statements are due within 75 days after the first three fiscal quarter ends of each year and 120 days after the fiscal year end.
   • For newly formed private funds, the rule requires a quarterly statement to be distributed beginning after the fund’s second full quarter of operating results.
   • If a quarterly statement is distributed electronically through a data room, this distribution, like other electronic deliveries, should be done in accordance with the SEC’s guidance regarding electronic delivery.
4. Consolidated Reporting for Certain Fund Structures: The rule requires advisers to take a principles-based approach to consolidate reporting for similar pools of assets to the extent doing so provides more meaningful information to the private fund’s investors and is not misleading.
   • For example, this may be applicable for master-feed structures where the adviser typically advises and controls all three funds, and the master fund typically makes and holds the investments. The rule would require the adviser to provide feeder fund investors with a single quarterly statement covering the applicable feeder fund and the feeder fund’s proportionate interest in the master fund on a consolidated basis, if it is not misleading.
5. Format and Content Requirements: The rule requires the adviser to use clear, concise, plain English in the quarterly statement.
   • Advisers should use a reasonable font size that is legible, margins and paper sizes that are reasonable (if applicable), and present information to facilitate review from one quarterly statement to the next.
   • If an adviser chooses to include additional information in the quarterly statement (i.e., information that is not required by the rule), this information must be short as practicable and not be more prominent than the required information.
6. Recordkeeping for Quarterly Statements: The SEC amended rule 204-2 (books and records rule) under the Advisers Act to require advisers to retain books and records related to the quarterly statement rule.
   • Advisers must make and retain a copy of any quarterly statement distributed to fund investors including the addressee and the date(s) the statement was sent.
   • Advisers must make and retain all records evidencing the calculation method for all expenses, payments, allocations, rebates, offsets, waivers, and performance listed on any quarterly statement.
   • Advisers must make and keep books and records substantiating the adviser’s determination that a private fund client is a liquid fund or an illiquid fund.

Restricted Activities Rule: New Rule 211(h)(2)(1) applies to all private fund advisers, regardless of registration status. The new rule focuses on transparency, requiring disclosure and, in some cases, consent before a private fund adviser:

• Uses fund assets to pay fees or expenses for an investigation of the adviser or its related persons by any governmental or regulatory authority (permitted with disclosure and consent)
  • The finer points: Charging the costs associated with a government investigation to the fund is only permitted if more than fifty percent of non-affiliated investors consent. Consent of a Limited Partners Advisory Committee is not sufficient under this rule.
  • Total prohibition: Private fund advisers are banned from charging costs associated with an investigation resulting in sanctions for violating the Advisers Act.
• Uses fund assets to pay any regulatory or compliance fees or expenses, or fees or expenses associated with an examination, of the adviser or its related persons (permitted with disclosure after the fact)
  • The finer points: Fees and costs for regulatory compliance may be charged to a fund if the adviser distributes disclosure of fees, including the amount, within 45 days after the end of the fiscal quarter. This disclosure can be included in the quarterly reports, and must include not only fees charged, but also allocated to the fund.
• Collects a clawback net of taxes applicable to the adviser, its related persons, or their respective owners or interest holders (permitted with disclosure after the fact)
  • The finer points: Clawbacks are allowed if written notice is provided to investors disclosing the amount of the clawback before and after any tax reduction, within 45 days after the end of the fiscal quarter. Disclosures can be included in the quarterly report.
• Allocates fees and expenses related to a portfolio investment (or potential portfolio investment) on a non-pro rata basis among funds and other clients (permitted with disclosure and explanation of why allocation if fair and equitable before the fact) (prohibited under proposal)
  • The finer points: Fees and expenses must be disclosed to investors before they are charged, and the adviser must provide an explanation about why the allocation is fair and equitable.
• Borrows from another fund managed by the adviser (permitted with disclosure and consent)
  • The finer points: The final rule requires an adviser to receive advance written consent from at least a majority in interest of a fund’s investors that are unrelated to the adviser beforehand. The notice must describe the material terms of the borrowing. The SEC suggested that this notice include the amount to be borrowed, the interest rate, and the repayment schedule.

The SEC also made changes to the recordkeeping requirements under Rule 204-2 of the Advisers Act requiring that private fund advisers retain a copy of any notification, consent, or other document distributed to or received from private fund investors under this rule, along with a record of each addressee and the corresponding date(s) sent for each such document distributed by the adviser.

Preferential Treatment Rule: New Rule 21(h)(2)-3 bans private fund advisers from providing preferential information to investors:

• If the information is expected to have a material negative effect on other investors in the fund or similar pool of assets, or
• The information is offered to all other investors in the fund or similar pool of assets at the same time.

The SEC grandfathered existing preferential redemption and information rights agreements in place prior to the compliance date.

For preferential treatment not prohibited under the rule, the adviser must provide advance written notice to prospective investors of preferential treatment regarding material economic terms (for example, the cost of investing, liquidity rights, fee breaks, and co-investment rights) given to other investors.

• For current investors, the adviser must provide written notice of preferential treatment.
• For illiquid funds, the adviser must provide disclosure at the end of the fundraising period.
• For liquid funds, the adviser must provide disclosure following the investor’s investment.

An annual written notice reflecting preferential treatment provided since the last written disclosure must be sent to all fund investors.

The Advisers Act recordkeeping rule (Rule 204-2) was amended to require advisers to retain copies of all written notices sent to current and prospective investors in a private fund under the Preferential Treatment Rule. Advisers must retain copies of a record of each addressee and the corresponding dates sent.

Adviser-led Secondaries: New Rule 211(h)(2)-2 defines an “adviser-led secondary transaction” as any transaction where a fund’s investors are offered two options, first to sell all or a portion of their interests in the fund, and second to convert (or exchange) all or a portion of their fund interests into interests in another vehicle managed by the adviser or its related persons.

The adviser is required to obtain an independent fair or valuation opinion. Additionally, the adviser must distribute a written summary of any material business relationships between it and the independent opinion provider. Whether a business relationship is “material” requires a facts and circumstances analysis. However, for purposes of the rule, audit, consulting, capital raising, investment banking, and other similar services would typically meet this standard.

The SEC also made changes to the recordkeeping requirements under Rule 204-2 of the Advisers Act, requiring advisers to maintain a copy of any fairness opinion or valuation opinion and material business relationship summary distributed under this rule, along with a record of each addressee and the corresponding date(s) sent.

Annual Fund Audits: New Rule 206(4)-10 requires SEC-registered private fund advisers to obtain audits of their private funds annually and upon liquidation. Securitized asset funds are excluded from this requirement. The audit requirement conforms to the Custody Rule (Advisers Act Rule 206(4)-2) audit requirements. If an adviser does not control the fund (e.g., unaffiliated sub-adviser), the adviser must take all reasonable steps to ensure that the audit takes place (assuming the fund is not already being audited). The SEC suggested including the audit requirement in sub-advisory agreements.

This new rule means that private fund advisers can no longer use surprise audits to comply with the custody rule. Moreover, the SEC rejected requests to waive the annual audit requirement for newly formed or liquidating entities, meaning that funds will incur expenses associated with audits for stub period and liquidation audits).

Interestingly, the SEC acknowledged that there may be situations where an adviser might not be able to distribute a fund’s audited financial statements by the relevant deadline because of unforeseen circumstances. In the Final Release, the SEC said that “if an adviser is unable to deliver audited financial statements in the timeframe required under the mandatory private fund adviser audit rule due to reasonably unforeseeable circumstances, this would not provide a basis for enforcement action so long as the adviser reasonably believed that the audited financial statements would be distributed by the deadline and the adviser delivers the financial statements as promptly as practicable.”

The Advisers Act Recordkeeping Rule (Rule 204-2) has been amended to require advisers to keep a copy of any audited financial statements, along with a record of each addressee and the corresponding date(s) sent.

Annual Compliance Review Documentation: Amended Rule 206(4)-7 requires that SEC-registered advisers document their review of the adequacy of their compliance policies and procedures and the effectiveness of their implementation efforts. While most SEC-registered advisers already document such reviews, this change may cause SEC examiners to closely scrutinize whether the reviews (i) clearly demonstrate why an adviser’s implementation of a policy is adequate; (ii) critically identify deficiencies uncovered; and (iii) present action-oriented plans to remedy any such deficiencies. Advisers should get ready - this rule amendment became effective 60 days after its publication in the Federal Register in November of 2023.

Our guidance

The new Private Fund Adviser Rules will require extensive implementation efforts, so private fund advisers should begin planning now. First steps include undertaking readiness assessments and gap analyses to develop project plans to manage all of the changes and interdependencies. Given this massive effort, many firms should consider leveraging compliance consulting support, outsourced managed services, and regulatory technology and data analytics.

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How we help

The Private Fund Adviser Rules require substantial implementation efforts with varying deadlines, the implications of which private fund advisers should begin considering and planning for now. This includes undertaking readiness assessments and developing detailed project plans to manage all the changes and interdependencies. 

Our people, processes, and technology can help simplify this task and help address all six of the new rules with:

• Private Fund Adviser Rule Readiness Assessment: Our tailored solution is designed to evaluate your firm's compliance program and investor reporting for alignment with these new rules.
• Quarterly Statements Solutions: Our tailored quarterly statement solutions help you navigate the complicated process and specifics around what is shown on these statements and how it must be calculated.
• ACA Signature: Our customized solutions combine compliance advisory, innovative technology, and managed services to provide expert solutions to assist firms with rule interpretation as well as modification and implementation of a firm’s compliance program.

Reach out to your ACA consultant or contact us to find out how we can help your firm comply with these rules.

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